An empirical evaluation of alternative fundamental models of credit spreads

Abstract

This study conducts an empirical comparison of how well alternative models of credit spreads explain CDS prices on 145 companies over the 2008–2019 interval. The results indicate that credit spreads are most closely related to theories which incorporate the likelihood of income insolvency into measures of the risk of jumps to default, with over half of individual CDS prices being explained, both during the financial crisis and thereafter. Out-of-sample tests using the same parameters estimated in-sample for all companies across time indicate that models which integrate the probability of income, cash, and valuation insolvency explain over 70% of spreads.